Question

Q.1.Three students have each saved $1,000. Each has an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the students’ investment projects:

Harry 5 percent

Ron 8 percent

Hermione 20 percent

a. If borrowing and lending is prohibited, so each student uses only his or her saving to finance his or her own investment project, how much will each student have a year later when the project pays its return?

e. At the equilibrium interest rate, how much does each student have a year later after the investment projects pay their return and loans have been repaid? Compare your answers to those you gave in part (a). Who benefits from the existence of the loanable funds market—the borrowers or the lenders? Is anyone worse off? With Graph???

Answer 1

When the three students are investing only the fund that they have. The amount that they will receive after a year will be

	Interest rate	Amount
Harry	5%	1000×1.05 = $ 1,050
Ron	8%	1,000×1.08 = $ 1,080
Hermione	20%	1,000 × 1.2 = $ 1,200

E. 8% is the equilibrium interest rate because at this rate Harry will supply fund, Ron will be indifferent as in either case he will receive 8% only. Hermione will demand fund at this rate. Thus, 8% is the equilibrium interest rate.

	Interest	Return
Harry	$ 1,000×1.08	$ 1,080	Better off
Ron	$ 1,000×1.08	$ 1,080	No change
Hermione	$ 2,000×1.2 -1,000×1.08	$ 1,320	Better off

Both lender as well as borrower are better off in the loanable fund market. As we can see Harry was lender and Hermione was lender and in comparison both the borrower and lender are better off. No one is worse off.

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